A mistake we might live to regret: Saurabh Srivastava

BANGALORE: IIS Inforech executive chairman Saurabh Srivastava reacted sharply to the introduction of tax on software exports. He said, "I believe it is a huge mistake to tax the software and services industry at this time and an even bigger mistake to remove the entire exemption over five years for the following reasons."

"The phenomenal growth of the software sector started in 1991 and was co-terminus with section 80HHE being introduced. Therefore, the correlation must be clear. The industry has not yet reached maturity, only a handful of companies have. Over 90 per cent of software companies are still very small and are in exactly the same position where the 10 per cent (who have achieved some maturity) were at the time that Income Tax exemption was given. These companies cannot sustain a 50 per cent or higher growth rate unless they reinvest all of their retained earning as they have no other source of funding since banks still believe in asset-based funding and the VC industry is yet to take off. If the tax is introduced, the growth rate of this industry will definitely suffer. The entire area of IT enabled services (which can be much larger than the software industry) is yet to take off and this industry usually finds it difficult to even get VC based funding. By imposing the tax now we may prevent this industry, which could be employing tens of millions of people within a decade, from taking off."

"The Indian software companies are already under significant pressure with various tariff and non-tariff trade barriers being imposed by US and EU nations, the net result of which is a pressure on our costs and margins. Imposition of tax at this point will squeeze the industry at both ends, seriously disrupt most companies' business models and definitely make us uncompetitive with our competitor countries such as China, Eastern Europe, etc."

"Under the WTO, each country is trying to give subsidies and protect those industries which are the ones where the country has a comparative advantage. We should be protecting our knowledge based industries to the hilt. I do not know whether there was WTO pressure but I do not believe so. Even if there was, we should have waited till there had been a significant negotiation and the matter had at least gone to arbitration.To put the matter in its perspective, the priority of the Finance Minister should have been to maximise gains from this sector. A closer look would reveal that this does not come from tax but from the growth of the industry. By removing 20% of the concessions, the tax collections would be around than US $ 30 mill. However, the phenomenal growth of the industry (US $ 100 mill to 4 bill in 10 years) has created a situation where the income tax paid by the employees must be in excess of US $ 300 mill. By slowing down the industry, the loss to the exchequer will be more than what is gained in tax. Other countries are trying to woo MNC's to come and set up their software and knowledge based industries by not only giving tax reliefs, but like in Ireland, even giving cash incentives."

"By contrast, if we are announcing the phase out of income Tax reliefs in five years we may be driving these companies elsewhere and destroying our growth model. I think the Finance Minister should have waited at least two years before starting the tax regime on software exports and should have moved it more gradually upwards. This is a mistake which we might live to regret. We might be just about to kill the goose that was laying the golden eggs. I certainly do applaud the Finance Minister's easing of norms on FII investments in software companies and simplification regarding the rules governing the Venture Capital industry. These should be of great benefit. Raising the dividend tax from 10 to 20% will clearly have an adverse impact on a lot of retail investors and may actually discourage companies at a marginal level to declare dividends. In the case of software companies, the dual impact of income tax and dividend tax will erode profit margins and dividends which would impact share values. This is turn will reduce market cap and erode their ability to do foreign acquisitions through stock swaps. This in turn will impact growth.